Subir Gokarn: Gearing up to compete

The recently established National Manufacturing Competitiveness Council (NMCC) has one very easy task before it, followed by one that will be very difficult.

The easy task is to identify the factors that are responsible for the relatively low level of competitiveness across the manufacturing sector. There is a wealth of analytical understanding and empirical evidence that demystifies the process of achieving and sustaining competitiveness.

The difficult task is to persuade the people who will have to implement the changes suggested by this understanding and evidence.

Achieving competitiveness in manufacturing is, by historical experience, not a particularly difficult objective. Enough countries have catapulted themselves from poverty to affluence in short periods of time by doing exactly this.

The macroeconomic manifestation of the process is that the growth rate of manufacturing (or, used interchangeably, industry) far exceeds that of aggregate GDP over a sustained period. As a consequence, the share of industry in GDP increases significantly.

By this simple macroeconomic criterion, India has not displayed manufacturing competitiveness. The share of industry in GDP has remained at about a quarter over the last two decades.

Its growth rate has exceeded that of the aggregate once in a while, but it has been quite volatile. By contrast, China, whose experience is representative of the other East Asian economies, saw its share of industry in GDP rise to about half by the end of the 1990s.

The implication is that, despite the breadth and depth of the reform process, it has not addressed some critical factors that make or break the competitiveness of this sector.

Looking at the experience of successful countries, we can identify the gap between what is and what should be, at least as far as competitiveness is concerned.

The general principle is quite straightforward. Competitiveness essentially means being able to produce at a cost that is equal to the best global benchmarks and still make money.

Broken down, this means that domestic producers of any commodity must have access to any tradable input at the best global price. Given this, the costs of non-tradable inputs""primarily infrastructure services and labour""determine the degree of competitiveness.

The costs of these inputs depend on their prices and their productivity; any disadvantage in one of these parameters can be partly offset by an advantage in the other.

Policy regimes oriented towards industrial competitiveness all converged on this formula sooner or later. From the macroeconomic perspective, the exchange rate was the key determinant of the external competitiveness of a country's products; export-dependent economies typically tried to undervalue their currencies.

At the microeconomic level, exports were completely exempt from indirect tax incidence, including customs duties, and the cost of capital was pegged to developed country standards, either through explicit subsidies or through attracting foreign investment.

This left the two key non-tradable inputs, infrastructure and labour. Public spending on infrastructure was the dominant mode when most of the East Asian economies were experiencing their rapid growth.

Private provision, wherever it has taken off, is a more recent phenomenon. Relying on domestic budgetary resources was generally not too constraining, because, for many of these countries, the initial surge in exports came from sectors that were not terribly vulnerable to low-quality infrastructure.

In fact, India is now doing extremely well in some of these sectors, like textiles, despite its obviously inadequate infrastructure. As growth accelerated, so did tax revenues.

Fiscal management in these countries has been typically tight, which created the room for stepping up public investment in infrastructure.

For all these countries labour was a relatively abundant resource and all of them were compelled to keep labour costs as low as possible. The approach varied across countries, but in all cases, either or both of two conditions were met.

Either employment was flexible""indicating an absence of binding job security regulations""or wages were flexible. For instance, the well-known Japanese institution of "lifetime employment", while protecting jobs, typically had a great deal of flexibility in re-setting wages and redeploying workers.

Other countries opted for more direct labour market flexibility. Countries like Malaysia and, later, China, which followed relatively rigid labour market policies, found the concept of the special economic zone a useful way to exempt producers from these policies, which would almost certainly have hindered their achievement of competitiveness.

The Indian situation detracts from competitiveness in manufacturing on three crucial fronts. Manufactures, particularly products being sold in the domestic market, bear a far higher tax burden than they should, partly because of the government's unwillingness or inability to tax the other sectors.

Even with all the tax exemptions and refunds for exports, there is still a residual burden, which makes a difference. More significantly, in order to escape that burden, a producer would have to remain small and insignificant, which denies him access to any economies of scale that might operate in the sector. It is truly a case of "damned if you do, damned if you don't'.

On infrastructure, while the prices and quality of service in many sectors are a serious constraint, as was pointed out above, one cannot think of a sequential approach to the problem.

Sectors that are less vulnerable to this bottleneck need to be facilitated for early take-off, even as infrastructure is being developed. But, here is the great irony.

By and large, these sectors are relatively labour-intensive; for them to take off, the labour market has to be oriented to competitiveness. As far as the manufacturing sector goes, ours definitely isn't. Flexibility has been achieved, to some degree, through voluntary retirement schemes and the like, but this is a one-sided achievement. Workers have been retrenched, but there is no corresponding inducement to hire people. Labour market flexibility needs to be full and it needs to be legitimised by policy and legislation.

That was the easy part. It has been so for the last 10 years, but in terms of putting these lessons to use, either there has been no action at all or it has been painfully slow. What the NMCC needs is a combination of an effective communication strategy and the power to negotiate with sources of resistance.

On each of these key issues, it will have powerful allies. However, some critical mass of change has to be achieved for it to have any lasting impact, which a cross-sectoral mechanism with a concretely defined objective is more likely to accomplish.

But, dealing with 10 years of inertia and obduracy is a difficult challenge, even for the best amongst us.

(The writer is Chief Economist, Crisil. The views are personal)